Volatility risk is the risk of a change of price of a portfolio as a result of changes in the
volatility of a risk factor. It usually applies to portfolios of derivatives instruments, where the volatility of its underlying is a major influencer of prices.
Sensitivity to volatility
A measure for the sensitivity of a price of a portfolio (or asset) to changes in volatility is
vega
Vega is the brightest star in the northern constellation of Lyra. It has the Bayer designation α Lyrae, which is Latinised to Alpha Lyrae and abbreviated Alpha Lyr or α Lyr. This star is relatively close at only from the Sun, a ...
, the rate of change of the value of the portfolio with respect to the
volatility of the underlying asset.
Risk management
This kind of risk can be managed using appropriate financial instruments whose price depends on the volatility of a given financial asset (a
stock, a
commodity, an
interest rate
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, ...
, etc.). Examples are
Futures
Futures may mean:
Finance
*Futures contract, a tradable financial derivatives contract
*Futures exchange, a financial market where futures contracts are traded
* ''Futures'' (magazine), an American finance magazine
Music
* ''Futures'' (album), a ...
contracts such as
VIX
VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options. It is calculated and disseminated ...
for equities, or
caps
Caps are flat headgear.
Caps or CAPS may also refer to:
Science and technology Computing
* CESG Assisted Products Service, provided by the U.K. Government Communications Headquarters
* Composite Application Platform Suite, by Java Caps, a Ja ...
,
floors
A floor is the bottom surface of a room or vehicle. Floors vary from simple dirt in a cave to many layered surfaces made with modern technology. Floors may be stone, wood, bamboo, metal or any other material that can support the expected load ...
and
swaptions for interest rates.
Risk management is the configuration and identification of analyzing, and or acceptance during
investment decision-making. In essence this occurs whenever an investor or portfolio manager evaluates potential losses within an investment. Under certain investment objectives, appropriate solutions (or no solution) will occur to assess the investors goals and standards.
Improper risk management can and or will negatively affect companies as well as their individuals. For example, the
recession that began in 2008 was largely caused by the loose credit risk management of financial firms.
See also
*
Derivative
In mathematics, the derivative of a function of a real variable measures the sensitivity to change of the function value (output value) with respect to a change in its argument (input value). Derivatives are a fundamental tool of calculus. ...
*
Implied volatility In financial mathematics, the implied volatility (IV) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model (such as Black–Scholes), will return a theoretical value equ ...
*
Market risk
Market risk is the risk of losses in positions arising from movements in market variables like prices and volatility.
There is no unique classification as each classification may refer to different aspects of market risk. Nevertheless, the most ...
*
Risk management
*
Standard deviation
*
Value at risk
Value at risk (VaR) is a measure of the risk of loss for investments. It estimates how much a set of investments might lose (with a given probability), given normal market conditions, in a set time period such as a day. VaR is typically used by ...
method
*
Volatility risk premium In mathematical finance, the volatility risk premium is a measure of the extra amount investors demand in order to hold a volatile security, above what can be computed based on expected returns.
It can be defined as the compensation for inherent v ...
References
Financial risk
Market risk
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